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Economic Development vs.

Economic Growth Development is a qualitative change, which entails changes in the structure of the economy, including innovations in institutions, behaviour, and technology Growth is a quantitative change in the scale of the economy - in terms of investment, output, consumption, and income. According to this view, economic development and economic growth are not necessarily the same thing. First, development is both a prerequisite to and a result of growth. Development, moreover, is prior to growth in the sense that growth cannot continue long without the sort of innovations and structural changes noted above. But growth, in turn, will drive new changes in the economy, causing new products and firms to be created as well as countless small incremental innovations. Together, these advances allow an economy to increase its productivity, thereby enabling the production of more outputs with fewer inputs over the long haul. Environmental critics and sustainable development advocates, furthermore, often point out that development does not have to imply some types of growth. An economy, for instance, can be developing, but not growing by certain indicators. Indeed, the measure of productivity should not be solely monetary; it should also address the issues like how effectively scarce natural resources are being used? How well pollution is being reduced or prevented? Etc. ECONOMIC DEVELOPMENT Economic Development is a branch of economics that deals with the study of macroeconomic causes of long term economic growth, and microeconomics; the incentive issues of individual households and firms, especially in developing countries. This may involve using mathematical methods from dynamical systems like differential equations and intertemporal optimization, or it may involve a mixture of quantitative and qualitative methods. Development is a phenomenon which occurs over a long period of time but economic growth is increase in GNP which can occur when we are able to achieve increase in number of resources or increase in technology or by the combination of both. Freidman defines growth as an expansion of the system in one or more dimensions without a change in its structure and development as an innovative process leading to the structural transformation of social systems. Thus Economic growth is related to a quantitative sustained increase in the countrys per capita output or income accompanied by expansion in its labor force, consumption capital and volume of trade. On the other hand economic wants goods incentives and institutions. Determination of Economic development Economic and Non economic Economic: 1. Natural resources 2. Labour and human resources 3. Structural changes: shift from primary sector to tertiary sector. 4. Size of market 5. Capital formation: 6. Capital Output ratio: It implies the amount of capital needed to produce one unit of output. Generally low capital output ratio is conducive for growth 7. Able entrepreneurs and organization 8. Development planning: it refers to that process in which a central planning authority plans for the achievement of certain targets within stipulated period of time given the resource base of the country concerned. 9. Skill formation Non Economic determinants 1. Political determinants 2. Social determinants 3. Aspiration of development 4. Freedom from corruption JOAN ROBINSON EQUILIBRIUM GROWTH MODEL Joan Robinson (1962) recommended a modification so as to understand the properties of this model better. We have not really discussed what determines investment: we simply posited a full employment relationship, i.e. I/Y = gv, so as to obtain Kaldor's steady-state. But surely, in a Keynesian world, an independent investment function should remain independent! Robinson (1962) posited a relationship I/Y = f(P/Y) or g = f(r), where investment decisions by firms were functions of (expected) profit. She argued that this was a concave function, based on Kalecki's (1937) principle of increasing risk: investment is positively related to expected profit, but at a decreasing rate - as every extra unit of investment means greater debt and thus greater risk to the firm. However, we know from the Kaldor relationship, P/Y = (1/s)I/Y or r = g/s, that profits are themselves generated by investment. Thus, Robinson's question can be asked: when is it true that the profits generated

by the investment in the Kaldor relationship will themselves generate investment decisions that, in turn, generate the original profits? Alternatively, what is there that guarantees that the profits generated by the Kaldor relationship will themselves generate the amount of investment needed to sustain them? This is a question of stability.

6. Figure 4 Robinson's (1962: p.48) diagram above of the concave Kalecki function and the linear increasing risk function is reproduced below. Assuming all is well, then we should have two equilibria where rs = g = f(r). Consider the rightmost equilibrium first. To the right of that equilibrium, Robinson posited that the economy was generating less profits than planned and thus investment plans will be shelved, inducing deaccumulation of capital and hence reducing growth. To the immediate left of it, the economy is generating more profits than planned, and thus firms will revise their expectations upwards and invest more, thereby increasing accumulation and growth. Hence, the right equilibrium is stable. A similar exercise will show that the left equilibrium is, for the same reasons, unstable. Robinson (1962) went on to enrich her analysis by introducing labor growth and to consider the implications of including unemployment and inflation and the method of adjustment explicitly in the model. She discusses the various types of growth situations that could be encountered - Golden Rule and otherwise. Another extension was provided by Luigi Pasinetti (1962). It is unlikely that workers do not save, as we have assumed. Originally, Kaldor (1955) proposed that workers did save out of wages, but less than capitalists - in which case, profits would be more sensitive to the investment decision than we have allowed. However, Pasinetti (1962) called this "a logical slip". If workers can save, we should conceive of two different "types" of capital falling under different ownership: "workers' capital" and "capitalists' capital". Let us call the former K' and the latter K. Thus total savings are S = sP + s'(P' + W), workers save out of both profits and wages. It is necessary that workers be paid a rate of interest on their capital just in the same manner as capitalists receive a rate of profit on theirs. By competition and arbitrage, Pasinetti argued that the rate of profit/interest for both capitalist and workers on their capital is equalized. Or: P/K = P'/K' = r where P' is workers' profits. For savings, let S be capitalist savings and S' worker savings out of profits. Therefore, for steady state growth: S/K = S'/K' = g In the long-run, for steady-state, it must be that the rate of accumulation must be equal for both capitalists and workers, i.e. P/S = P'/S' otherwise, if the rate of wealth accumulation is faster for either of the classes, then there will be a change in distribution and, as a result, a change in the composition of aggregate demand. In long-run equilibrium, aggregate demand must be stable therefore this is a necessary assumption. However, as a consequence of this assumption, we can note that: P/sP = P'/s'(W + P') where s and s' are the marginal propensity to save of capitalists and workers. Note again that workers also save out of wages, W, as well as profits, P', whereas capitalists only receive and save out of profits. Crossmultiplying: s'(W + P') = sP'


Now, if investment (I) is equal to total savings which means that: I = s'(W + P') + sP then using our previous relationship: I = sP' + sP = s(P + P') Let us call total profits P* = P + P', then I = sP* or: P* = (1/s)I So it must be that: r = (P*/K) = (1/s)I/K = g i.e., for long run Golden Rule steady-state growth, only the capitalist's propensity to save needs to be considered - workers' saving propensities can be dropped by the wayside. Thus, even with worker savings, the "Cambridge rule" is iron-clad. Only capitalists' savings propensity matters. As Pasinetti notes: But there were important assumptions in the model yet undiscussed. Pasinetti posits one of his conditions to guarantee existence to be: s > I/Y > s' so that profits cannot take "a null or negative share of wages" . This, in essence, defines the mechanism for adjustment. If distribution can be somehow organized such that there will be a "correct" level of profits to give us the savings necessary to be in equilibrium: i.e. make I/K = s/v. The first question that must be asked here is not only whether you can calculate for a given investment level what the profit level will be but whether there will be pressures that might bring this into equilibrium. Within certain limits, Kaldor argues, variations can take place such that P/Y is a function of the change in the I/Y ratio. According to Kaldor, prices respond to relative money wage rates as a consequence of demand. Assume, for instance, that given an excess demand for goods, prices will increase but not wages. As a consequence there is a shift in distribution such that there will be an increase in the profit share. Since profits increase, this implies there will be a substantial growth in savings. Exogenous growth model (Solow-Swan growth model) The Exogenous growth model, also known as the Neo-classical growth model or Solow-Swan growth model is a term used to sum up the contributions of various authors to a model of long-run economic growth within the framework of neoclassical economics Development of the model The Neo-classical model was an extension to the 1946 Harrod-Domar model that included a new term, productivity growth. The most important contribution was probably the work done by Robert Solow; in 1956, Solow and T.W. Swan developed a relatively simple growth model which fit available data on US economic growth with some success. Solow received the 1987 Nobel Prize in Economics for his work on the model. Solow also was the first to develop a growth model with different vintages of capital. The idea behind Solow's vintage capital growth model is that new capital is more valuable than old (vintage) capital because capital is produced based on known technology and because technology is improving. Both Paul Romer and Robert Lucas, Jr. subsequently developed alternatives to Solow's neo-classical growth model.Today, economists use Solow's sources-of-growth accounting to estimate the separate effects on economic growth of technological change, capital, and labor. Extension to the Harrod-Domar model Solow extended the Harrod-Domar model by: Adding labor as a factor of production; Requiring diminishing returns to labor and capital separately, and constant returns to scale for both factors combined; Introducing a time-varying technology variable distinct from capital and labor. The capital-output and capital-labor ratios are not fixed as they are in the Harrod-Domar model. These refinements allow increasing capital intensity to be distinguished from technological progress. Short run implications Policy measures like tax cuts or investment subsidies can affect the steady state level of output but not the longrun growth rate. Growth is affected only in the short-run as the economy converges to the new steady state output level. The rate of growth as the economy converges to the steady state is determined by the rate of capital accumulation. Capital accumulation is in turn determined by the savings rate (the proportion of output used to create more capital rather than being consumed) and the rate of capital depreciation. Long run implications In neoclassical growth models, the long-run rate of growth is exogenously determined - in other words, it is determined outside of the model. A common prediction of these models is that an economy will always converge towards a steady state rate of growth, which depends only on the rate of technological progress and the rate of labor force growth.

A country with a higher saving rate will experience faster growth, e.g. Singapore had a 40% saving rate in the period 1960 to 1996 and annual GDP growth of 5-6%, compared with Kenya in the same time period which had a 15% saving rate and annual GDP growth of just 1%. This relationship was anticipated in the earlier models, and is retained in the Solow model; however, in the very long-run capital accumulation appears to be less significant than technological innovation in the Solow model. Assumptions The key assumption of the neoclassical growth model is that capital is subject to diminishing returns. Given a fixed stock of labor, the impact on output of the last unit of capital accumulated will always be less than the one before. Assuming for simplicity no technological progress or labor force growth, diminishing returns implies that at some point the amount of . new capital produced is only just enough to make up for the amount of existing capital lost due to depreciation At this point, because of the assumptions of no technological progress or labor force growth, the economy ceases to grow. Assuming non-zero rates of labor growth complicates matters somewhat, but the basic logic still applies - in the short-run the rate of growth slows as diminishing returns take effect and the economy converges to a constant "steady-state" rate of growth (that is, no economic growth per-capita). Including non-zero technological progress is very similar to the assumption of non-zero workforce growth, in terms of "effective labor": a new steady state is reached with constant output per worker-hour required for a unit of output. However, in this case, per-capita output is growing at the rate of technological progress in the "steady-state" (that is, the rate of productivity growth). Variations in productivity's effects Within the Solow growth model, the Solow residual or total factor productivity is an often used measure of technological progress. The model can be reformulated in slightly different ways using different productivity assumptions, or different measurement metrics: Average Labor Productivity (ALP) is economic output per labor hour. Multifactor productivity (MFP) is output divided by a weighted average of capital and labor inputs. The weights used are usually based on the aggregate input shares either factor earns. This ratio is often quoted as: 33% return to capital and 66% return to labor (in Western nations), but Robert J. Gordon says the weight to labor is more commonly assumed to be 75%. In a growing economy, capital is accumulated faster than people are born, so the denominator in the growth function under the MFP calculation is growing faster than in the ALP calculation. Hence, MFP growth is almost always lower than ALP growth and growth. (Therefore, measuring in ALP terms increases the apparent capital deepening effect.) Technically, MFP is measured by the "Solow residual", not ALP.. Empirical evidence A key prediction of neoclassical growth models is that the income levels of poor countries will tend to catch up with or converge towards the income levels of rich countries as long as they have similar characteristics - like for instance saving rates. Since the 1950s, the opposite empirical result has been observed on average. If the average growth rate of countries since, say, 1960 is plotted against initial GDP per capita (i.e. GDP per capita in 1960), one observes a positive relationship. In other words, the developed world appears to have grown at a faster rate than the developing world, the opposite of what is expected according to a prediction of convergence. However, a few formerly poor countries, notably Japan, do appear to have converged with rich countries, and in the case of Japan actually exceeded other countries' productivity, some theorize that this is what has caused Japan's poor growth recently - convergent growth rates are still expected, even after convergence has occurred; leading to over-optimistic investment, and actual recession. The evidence is stronger for convergence within countries. For instance the per-capita income levels of the southern states of the United States have tended to converge to the levels in the Northern states. These observations have led to the adoption of the conditional convergence concept. Whether convergence occurs or not depends on the characteristics of the country or region in question, such as: Institutional arrangements Free markets internally, and trade policy with other countries. Education policy Evidence for conditional convergence comes from multivariate, cross-country regressions. If productivity were associated with high technology then the introduction of information technology should have led to noticeable productivity acceleration over the past twenty years; but it has not Econometric analysis on Singapore and the other "East Asian Tigers" has produced the surprising result that although output per worker has been rising, almost none of their rapid growth had been due to rising per-capita productivity (they have a low "Solow residual"). Criticisms of the model Empirical evidence offers mixed support for the model. Limitations of the model include its failure to take account of entrepreneurship (which may be catalyst behind economic growth) and strength of institutions (which facilitate economic growth). In addition, it does not explain how or why technological progress occurs. This failing has led to the development of endogenous growth theory, which endogenizes technological progress and/or knowledge accumulation.

Some critics suggest that Schumpeters 1939 Theory of Business Cycles, modern Institutionalism and Austrian economics offer an even better prospect of explaining how long run economic growth occur than the later Lucas/Romer models. Graphical representation of the model

Figure 1 The model starts with a neoclassical production function Y/L = F(K/L), rearranged to y = f(k), which is the orange curve on the graph. From the production function; output per worker is a function of capital per worker. The production function assumes diminishing returns to capital in this model, as denoted by the slope of the production function. n = population growth rate d = depreciation k = capital per worker y = output/income per worker L = labor force s = saving rate Capital per worker change is determined by three variables: Investment (saving) per worker Population growth, increasing population decreases the level of capital per worker. Depreciation - capital stock declines as it depreciates. When sy > (n+d)k, in other words, when the savings rate is greater than the population growth rate plus the depreciation rate, when the green line is above the black line on the graph, then capital (k) per worker is increasing, this is known as capital deepening. Where capital is increasing at a rate only enough to keep pace with population increase and depreciation it is known as capital widening. The curves intersect at point A, the "steady state". At the steady state, output per worker is constant. However total output is growing at the rate of n, the rate of population growth. The optimal savings rate is called the golden rule savings rate and is derived below. In a typical Cobb-Douglas production function the golden rule savings rate is alpha. Left of point A, point k1 for example, the saving per worker is greater than the amount needed to maintain a steady level of capital, so capital per worker increases. There is capital deepening from y1 to y0, and thus output per worker increases. Right of point A where sy < (n+d)k, point y2 for example, capital per worker is falling, as investment is not enough to combat population growth and depreciation. Therefore output per worker falls from y2 to y0. The model and changes in the saving rate

Figure 2 The graph is very similar to the above; however, it now has a second savings function s 1y, the blue curve. It demonstrates that an increase in the saving rate shifts the function up. Saving per worker is now greater than population growth plus depreciation, so capital accumulation increases, shifting the steady state from point A to B. As can be seen on the graph, output per worker correspondingly moves from y0 to y1. Initially the economy expands faster, but eventually goes back to the steady state rate of growth which equals n. There is now permanently higher capital and productivity per worker, but economic growth is the same as before the savings increase. The model and changes in population


This graph is again very similar to the first one, however, the population growth rate has now increased from n to n 1, and this introduces a new capital widening line (n1 + d)